For Sale

Joe Heider wasn't looking to sell his practice last year. But the president of what was then called Dawson Wealth Management, a Cleveland, Ohio-based RIA with about $400 million in assets, was mulling over ways to expand his business, provide more opportunities to his 14 employees, and plan for his succession 10 or so years down the line.

So, when folks from Rehmann, a large Troy, Mich.-based CPA firm, approached Heider about merging his business into theirs, Heider was intrigued. Like most advisory practices, Heider's assets were down and his valuation would likely take a hit. But, “We'd have a deeper bench in terms of CFAs and back-up people,” he says. “We'd just grow much, much faster as part of Rehmann.” After six months of talks, the deal went through, making Heider an equity partner in Rehmann.

Despite all the news about the decrease in M&A activity recently, the fact is, there's still lots of action going on — and a lot of interested buyers. Still, for the seller, it's an odd time. While a large pool of potential purchasers exists, valuations for many RIAs of all sizes have declined, thanks to market turmoil. The bottom line: It's possible to end up with a deal that works for you, as long as you're aware of what today's market requires. That means everything from negotiating a valuation you can live with to persuading potentially skittish clients the sale is in their best interest.

Perhaps the most critical consideration is the one that should start the process: determining exactly why you're selling. Are you retiring? Planning to get out of the business? Trying to expand? The answer will determine the type of buyer likely to be interested in your practice. If you think the best way to expand your business is for certain employees to take a stake in the firm's future, for example, then that will dictate the route you take. On the other hand, if you've decided to expand by merging with a like-minded firm, you'll follow a different path. Or, you might want to sell to an outsider, gather as much money as you can, and sail off into the sunset. That objective will mean choosing another tack.

Heider is a case in point. He wanted access to resources he couldn't get on his own and opportunities for growth for his employees, among other things. For him, merging with a much larger firm did the trick. For Sandra White, co-founder of Green/White Advisors in Houston, the issue was different. Her partner wanted to retire for health reasons. They first thought White should buy her partner's 50 percent share. But, with no one else in the firm as an appropriate successor, “there would be nothing in place if something happened to me,” she says. Instead, in April, they signed an agreement to sell the practice, which had $100 million in assets, to United Capital Financial Advisers, a consolidator that provides back office, compliance and other functions. The arrangement gives White a backup. If something happened to her, another firm under the United Capital umbrella could work with her clients.

Determining valuation and deal structure is even trickier. Valuations are generally based on a multiple of revenue or profits, not the greatest metric for most sellers at the moment. One solution, according to Mary Sterk, president of Sterk Financial Services in Dakota Dunes, SD, is to propose that the valuation be calculated based on a three-year average of revenues, instead of the usual 12 months. Your most persuasive argument is likely to be that a valuation calculated over just the previous year won't show an accurate snapshot of performance. But be prepared, in that case, for the buyer to ask for a five-year-average. You'll need to be ready to explain any big spikes that happened during whatever time period you use.

Other factors play a part in valuation, too. A big one is cash flow. “That's what pays the investor back on his investment,” says David Devoe, director of mergers & acquisitions at Schwab Institutional. Having recurring revenues generally increases a valuation, a plus for RIAs. Another consideration is the ability to mitigate risk — a firm serving, say, a client base with an average age of 45 might fare better than a practice with too many 75-year-olds.

Before you let the buyer peruse your financials, evaluate your expenses. If you're like many advisors, you may not be aware of just what they are and, most important, whether you're charging too many personal items to the business — a car, say, or cell phone. The point is, you might be able to improve your valuation if you can pinpoint costs likely to disappear after the sale. “You need to be able to document and explain just what's sitting on the books that you can remove,” says Sterk.

Equally important is how you structure the deal. While it's likely to be a mix of cash, equity, notes and earn-out, you might do better if, like Heider, you take a longer earn-out. Heider agreed to an earn-out of seven years. Such a compromise, in fact, can be the key to addressing what Corey Kupfer, chief strategist with MarketCounsel in Englewood, NJ, calls “valuation tension.” Recently, he worked with the owner of an RIA who was negotiating with two junior associates to sell them a partial stake. Neither side seemed able to come close to an agreement, however. The owner, according to Kupfer, was “at about 150 percent of the other guys' starting number.” Kupfer, then, suggested the junior associates accept a figure on the higher side if the senior partner agreed to a seven year earn-out instead of the three years that was originally suggested. It worked.

Once the deal is done, there are a number of other key considerations. How you break the news to clients can mean the difference between a successful transition and a disaster. It's particularly important now, because clients may still be dizzy from the market's ups and downs and in no mood for a major change. For that reason, spend time forming a persuasive message and a plan for how you'll convey it. “The point needs to be that you trust the buyer and that you've been working for a long time to find just the right one,” says Sterk. If you're merging with or selling to a much larger practice and the client is likely to work with many new advisors, then tweak the message to emphasize your trust in the firm, as opposed to the individual buyer.

Be prepared for clients who take the move as a sign you're in trouble. It's unlikely they'll come out and say so, but you might be able to read between the lines. When Scott Leonard decided to merge his firm, a Redondo Beach, Calif., practice with about $200 million in assets, with a La Jolla, Calif., firm, in the fall of 2008,“I knew a few clients were thinking I must not be doing well,” he says. “They said some things indirectly to let me know.” To handle the problem, Leonard simply made sure to be explicit with these clients about his rationale for forming the new firm, Trovena, and to emphasize that they'd worked on the plan for more than a year, beginning negotiations before the downturn.

Your best bet is to talk to all your clients individually, or, at least, to your top accounts. Heider, for one, met with his largest 100 clients either in person or on the phone to discuss the sale. Then, he sent out a letter to all his clients explaining the benefits and assuring them that such things as fee structure and portfolio reviews wouldn't change. What's more, after the sale, he distributed client surveys about the change to be filled out anonymously. None of his clients has left.

Fact is, if you're dragging your feet, keep in mind the demographics: Over the next 10 to 15 years, as more advisors retire, we're likely to see a wave of practices for sale. You might want to start testing the waters before you have a lot of competition.

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